Stella Koukounis November 9 2020 Key considerations when reducing a company's share capital Solsidus Law | Corporate & Commercial - Cyprus Stella Koukounis Corporate & Commercial IntroductionWhat constitutes a reduction of a Cypriot company's share capital? ProcedureWhat do the courts look for when evaluating applications for a reduction of share capital?When is reduction effective?What happens to shareholders' liability on reduced share capital?Could the reduction procedure be improved?IntroductionShare capital represents a company's lifeline. It is the means by which a company receives the funds necessary to operate, invest, pay its personnel, maintain utilities and function. Shareholders that pay funds into a company receive shares in that company in return. The value of the shares received is usually two-fold, the nominal value and the market value which fluctuates representing, in most cases, the company's performance. Nevertheless, there are instances where a company no longer requires the share capital paid in by its shareholders. This could be due to a change in investment goals or the scope of the company's investment activity as a response to the market's downturn, an economic crisis or a reorganisation.To better demonstrate the key considerations when reducing a company's share capital, it is important to briefly mention that a Cypriot company may increase its share capital by a shareholders' decision and the directors are then free to offer these shares pro rata to the shareholders against a price. That price may be just the nominal value per share, or it may have an added price, called a share premium. Paid share capital and the share premium account both represent the company's equity. They are also non-refundable reserves, the reduction of which requires the steps and key considerations analysed further below.What constitutes a reduction of a Cypriot company's share capital? Sections 64 to 68 of the Companies Law (Cap 113) govern the reduction of share capital in Cypriot companies. The decision to reduce share capital rests with a company's shareholders, provided that this is also permitted by the company's articles of association. Ultimately, the courts must approve the reduction of share capital by order following a petition filed by the company.When reducing its share capital, a company by special resolution of the shareholders may decide to:extinguish or reduce the liability on any of its shares in respect of share capital not paid up;cancel any paid-up share capital which is lost or unrepresented by available assets with or without extinguishing or reducing the liability on any of its shares;pay off any paid-up share capital which is in excess of the wants of the company with or without extinguishing or reducing the liability on any of its shares;cancel paid-up share capital for the purpose of writing off the company's losses; orcancel paid-up share capital by the creation of a reserve, to be called 'the capital reduction reserve fund', which will be subject to the same treatment as the share premium account.ProcedureA reduction of share capital, share premium or any other non-refundable reserve:must be permitted by the company's articles of association;requires special resolution of the company's shareholders (or resolution reached by such higher majority as fixed in the company's articles of association); andrequires a court order approving the reduction of share capital.What do the courts look for when evaluating applications for a reduction of share capital?The decision to reduce a company's share capital rests with its shareholders – the persons that are ultimately affected by it. Nevertheless, as a gatekeeper for other company stakeholders, the courts exercise their legislative powers in approving the application to reduce share capital or not. At the heart of the courts' concern is the legitimacy of the reduction – is the intention to reduce truly based on commercial grounds or is it a masked effort to strip a company of its assets?Article 66 of the Companies Law provides that the courts may insist on the company adding 'and reduced' to its name or publishing an explanation of the reduction. In reaching its decision on whether to approve a reduction of capital, the courts have been held to consider, among other things, whether:all shareholders have been treated equitably;the reduction proposals have been properly explained;creditors' or third parties' interests have been prejudiced; andthe reduction has a discernible purpose.The Companies Law provides certain safeguards to protect creditors and in practice the courts are more likely to approve a reduction of share capital when it has been adequately proven that creditors have been informed of the decision to reduce the share capital or reserve and have consented thereto. On the contrary, where creditors are not informed and consequently cannot consent to the procedure, the courts are less likely to approve the reduction application. In reaching their decision, the courts may consider whether there are alternative ways for the protection of the creditors, such as:the provision of third party guarantees, the appropriation of cash in an account dedicated specifically to the payment of those creditors, and the subordination of the claims of consenting creditors to those of non-consenting creditors.(1)In reaching their decision, the courts will evaluate all of the facts of a particular case, including:the COVID-19 pandemic;creditors' availability;banks' digital presence; andforce majeure conditions.When is reduction effective?Once a court confirms the reduction of share capital, a copy of the court's order approving the reduction along with a copy of the court's statement outlining the new capital structure of the company is filed to the Registrar of Cyprus Companies for registration.The registration of the court's order and statement with the Registrar of Cyprus Companies is a vital step in the procedure for the reduction of share capital of a company as:the reduction is effective only after the court order and the attached resolution for reduction are both filed with the registrar; andthe certificate issued by the registrar constitutes conclusive evidence that all legal requirements pertaining to the reduction of share capital have been complied with and that the company's share capital is as it is represented in the corresponding certificate.What happens to shareholders' liability on reduced share capital?Following the reduction of share capital, shareholders cease to be liable for calls or other contributions as regards the amount by which the nominal amount of their shares has been reduced.Could the reduction procedure be improved?There are several arguments in favour of amending the Companies Law on this point, so that recourse to the courts applies only to share capital reductions of public and publicly listed companies or that the court procedure itself become simplified. The court procedure could be simplified by allowing applicants to refer to agreed practice directions and fill in questionnaires outlining the important legal considerations which the courts may raise during the hearing and which the courts expect to see in evaluating the merits of a reduction application (eg, presentation of solvency declarations, creditor consents and substantiated reasons for the reduction), thus streamlining reduction of share capital petitions. Shareholders, creditors and other stakeholders have much to lose on an inappropriate reduction of share capital; therefore, keeping an objective eye on the whole process is wise.For further information on this topic please contact Stella Koukounis at Solsidus Law by telephone (+357 22 007700) or email ([email protected]). The Solsidus Law website can be accessed at www.solsiduslaw.com.Endnotes(1) Sportech Plc  CSOH 58.